Dow Average More Accurate Than Many Think

LINDA STERN Your Money

Probably not. For 100 years investors have been basing their stock market opinions on this index of big American companies. It has become the market analysts' short cut for the stock-market universe.

Critics have blasted the index, which includes 30 companies such as McDonald's, Boeing, Merck and Exxon, as not being reflective of the broader and more modern stock market.

But that turns out not to be very true. As a measure of stock activity, the index's composition of big companies from a variety of sectors tends to work well: It correlates closely to the ups and downs of the larger Standard & Poor's index of 500 big stocks, though it tends to outperform that index by about 2 percent a year.

The other criticism of the Dow: What is the Dow? You can't buy it anywhere, can you?

You can, albeit for a price. For the last five years one mutual fund has aimed to do nothing more or less than buy the Dow. The ASM fund, headquartered in Tampa, acts like a limited index fund: It buys the 30 companies in the Dow and sits on them.

In 1995, the fund earned 29 percent, and its three-year average return is 13.9 percent, compared to the average growth stock fund returns of 29.8 percent and 13.1 percent.

For those returns, however, ASM fund shareholders have paid a price. Though the fund is a true no-load fund with no sales fees of any kind attached to it, and no 12(b)1 marketing fee, it does have a high expense ratio for a mildly managed fund of this kind: ASM managers have been taking 2 percent of assets to get the fund going.

In August, that will change, and the fund's expense ratio will drop to 0.18 percent promises the fund's founder, Steven Adler. That is a good price and far less than most investors would have to spend if they were going to buy the Dow on their own.

But you can buy the Dow on your own if you want to, and many investment advisers have made careers out of figuring optimum combinations of these 30 stocks: Allied Signal, Alcoa, American Express, AT&T, Bethlehem Steel, Boeing, Caterpillar, Chevron, Coca-Cola, Disney, DuPont, Eastman Kodak, Exxon, General Electric (the only charter member), General Motors, Goodyear, IBM, International Paper Co., McDonald's, Merck, Minnesota Mining and Manufacturing Co., J.P. Morgan, Philip Morris, Procter & Gamble, Sears, Texaco, Union Carbide, United Technologies, Westinghouse and Woolworth.

A popular theory for buying the Dow is to aim for the five or 10 companies that have the highest dividend yield and switch every year. Adherents claim this maximizes the growth potential of the Dow stocks as those high-yielding company prices adjust to match their dividends.

Several brokerage firms, including Merrill Lynch, offer fixed "select 10" portfolios twice a year that follow those guidelines. It costs more to get into one of those portfolios than to get into Adler's fund.

Many other mutual funds also end up with Dow stocks as big parts of their portfolios: Once a growth stock fund has gotten large, it often is hard to invest all shareholder money without firms such as GE, AT&T, Disney and Philip Morris.

Adler says it isn't the pricing ebbs and flows that make the Dow such a good buy; it is the activities of the companies. Almost 40 percent of the revenues these companies receive come from foreign business activities. In these 30 stocks you get the performance of the SP 500 plus a foreign stock play, he says.

But when you buy the Dow, you aren't getting everything. You are not getting any small stocks, and that is where the biggest growth is.

Across time, small stocks have outperformed all stocks by about 2 percent a year, says Ibbotson Associates in Chicago. A smart strategy might involve buying into the Dow either directly or through ASM Fund (after August's price drop) and balancing that with a small-stock focused mutual fund.

Linda Stern writes for Reuters. Her column appears on Mondays. She can be reached by e-mail at 72160.1546(AT)compuserve.com or writing Reuters, Suite 410, 1333 H. St., NW, Washington, D.C. 20005.